OFFSHORE TRUSTS AND RELATED ASSET PROTECTION STRATEGIES FOR REAL ESTATE OWNERSHIP

OFFSHORE TRUSTS AND RELATED ASSET PROTECTION STRATEGIES FOR REAL ESTATE OWNERSHIP MARIO A. MATA WRIGHT & GREENHILL, P.C. 221 West 6th Street, Suite 1800 Austin, Texas 78701 Telephone: 512/ 476-4600 Facsimile: 512/ 476-5382 E-mail: mmata@w-g.com DALLAS BAR ASSOCIATION REAL PROPERTY SECTION October 11, 1999 1999 Mario A. Mata All Rights Reserved

Dallas, Texas 1999 Mario A. Mata All Rights Reserved

MARIO A. MATA Wright & Greenhill, P.C. BIOGRAPHICAL INFORMATION EDUCATION J.D., The University of Texas, 1978 B.B.A. in Accounting with Honors, The University of Texas, 1976 PROFESSIONAL ACTIVITIES Shareholder, Wright & Greenhill, P.C., Austin, Texas Board Certified in Commercial Real Estate Law,1990-1998 Certified Public Accountant, Texas, 1981-1985 American Bar Association (Member: Asset Protection Planning Committee) International Tax Planning Association SEMINAR AND CONFERENCE PRESENTATIONS "Offshore Trusts and Related Asset Protection Strategies", 1999 Advanced Estate Planning Conference, Texas Society of Certified Public Accountants, 1999. "Offshore Trusts and Related Wealth Preservation Strategies", Wills and Probate Institute, University of Houston Law Foundation (scheduled July, 1999). "Offshore Trusts and Related Asset Protection Strategies for Real Estate Ownership", 21st Annual Advanced Real Estate Law Course, State Bar of Texas. "Money Laundering Legislation and Case Law Developments in the U.S. of Relevance to the Asset Protection Planner", Strategic Planning through Offshore Trusts and Related Asset Protection Techniques, Professional Education Systems, Inc., 1999 "Mobile Wealth: The Offshore Trust and Other Vehicles for Protecting Assets", Texas Marital Property Institute, University of Texas School of Law, 1998 "Use of Partnerships with Offshore Trusts for Asset Protection", Current Issues Affecting Partnerships, Limited Partnerships and Limited Liability Companies, University of Texas School of Law, 1998 "Offshore Trusts and Other Wealth Planning Alternatives", Corporate, Partnership & Business Law Institute; University of Houston Law Foundation; 1998. "Offshore Trusts and Other Asset Protection Strategies: Uses and Abuses", Collecting Debts and Judgments, University of Houston Law Foundation; 1998. "Family Limited Partnerships, Offshore Trusts and Other Wealth Planning Alternatives", Business and Estate Planning; University of Houston Law Foundation; 1997 and 1998. "Asset Protection Strategies for Small Businesses and Their Owners", Advising Small Business Owners, University of Houston Law Foundation; 1997 and 1998.

"Asset Protection Strategies in Business Planning: Use of Offshore Trusts and Family Limited Partnerships to Maximize the Preservation of a Client's Wealth", Corporate, Partnership & Business Law Institute; University of Houston Law Foundation; 1996 & 1997. 4 1999 Mario A. Mata All Rights Reserved

OFFSHORE TRUSTS AND RELATED ASSET PROTECTION STRATEGIES FOR REAL ESTATE OWNERSHIP Mario A. Mata Wright & Greenhill, P.C. TABLE OF CONTENTS I. INTRODUCTION... 1 II. TRADITIONAL FORMS OF ASSET PROTECTION PLANNING... 2 A. Exemption Planning... 2 B. Domestic Trust... 4 III. THE ALASKA "ONSHORE" TRUST... 6 A. The Alaska Trust Act... 7 B. Disadvantages and Potential Pitfalls... 7 IV. USE OF FAMILY LIMITED PARTNERSHIPS AND LLC s... 7 A. Valuation Discount... 8 B. Income Shifting Benefits... 8 C. Asset Protection Benefit... 8 D. Offshore Limited Partnerships... 10 V. FOREIGN SITUS TRUST... 10 A. Benefits of Foreign Situs Trust... 11 B. Selecting a Favorable Jurisdiction... 13 VI. STRUCTURING AN OFFSHORE ASSET PROTECTION TRUST.... 13 A. Significant Offshore Trust Provisions... 14 B. Use of Partnerships with Offshore Trust... 16 VII. OVERVIEW OF APPLICABLE FOREIGN LAW... 17 A. Bahamas... 17 B. Bermuda... 19 C. Cayman Islands... 20 D. Cook Islands... 22 Page 5

E. Isle of Man... 24 F. Liechtenstein... 25 6

TABLE OF CONTENTS (continued) G. Nevis... 27 H. St. Vincent and the Grenadines... 30 I. Switzerland... 31 VII. U.S. INCOME TAX CONSIDERATIONS... 32 A. Typical Grantor Retained Powers in an Offshore Trust... 32 B. Grantor Trust Rules... 33 C. Application of Grantor Trust Rules to Foreign Situs Trust... 33 D. Estate Tax Consequences... 33 E. Taxation of Transfers to Foreign Trusts... 34 F. 1996 Foreign Trust Amendments... 34 G. Tax Deferral Using Foreign Non-Grantor Trusts... 39 VIII. BANKRUPTCY AND FRAUDULENT CONVEYANCE ISSUES... 41 A. Bankruptcy Fraudulent Transfer Provisions... 41 B. Texas Uniform Fraudulent Transfer Act... 42 C. Conversion of Non-Exempt Property... 43 D. Fraud on Spouse... 44 IX. MONEY LAUNDERING TRAPS FOR THE UNWARY... 46 A. History of Money Laundering Law... 46 B. Money Laundering Provisions of 18 U.S.C. 1956... 48 C. Financial Transactions Involving "Criminally Derived" Property... 52 D. Effect on Attorney-Client Relationships... 56 X. OTHER CRIMINAL PITFALLS FOR CLIENTS AND THEIR ATTORNEYS... 58 A. Bankruptcy Crimes... 58 B. Tax Crimes... 58 XI. OTHER ETHICAL CONSIDERATIONS... 62 A. Professional Standards of Conduct... 62 B. Confidentiality and the Attorney-Client Privilege... 62 XIII. CONCLUSION... 63 7

I. INTRODUCTION The use of offshore trusts to legitimately maximize the protection of a client's personal wealth has gained new recognition and acceptance in today's litigious society. Now, more than ever, any business or estate plan requires an examination of the risk associated with the client's activities and business holdings. Attorneys and other professionals must consider the benefits, goals, issues and risks involved in establishing an offshore trust as part of a comprehensive asset preservation plan for the wealthy client, business owner or executive with significant business holdings or investments. The benefits of an offshore trust are all too obvious in those situations when a client without an offshore trust, but with substantial assets at risk, becomes a defendant in a serious lawsuit. If such a client has not already protected his or her assets with an offshore trust, the client could face financial ruin. Unfortunately, many clients and their lawyers never consider the benefits of an offshore asset protection trust until it is too late. Attorneys should be prepared to adequately advise the client at risk about the benefits of an offshore trust. The businessman turned defendant by a major lawsuit is unlikely to question the merits or moral significance of protecting one s assets with a professionally established offshore trust. If he has not already protected his personal assets with a trust prior to the threat of litigation arising, the client is more likely to ask why his lawyer did not advise him to at least investigate the merits of using an offshore trust to protect his personal assets. In fact, it is this author's belief that failure to so advise a wealthy or at risk client may constitute malpractice if the client's assets are needlessly exposed to a subsequent judgment or other legal claim. This paper will focus primarily on the proper use of an offshore trust for legitimate asset protection purposes. However, an extensive discussion of the applicable bankruptcy, fraudulent conveyance, money laundering and other civil and criminal pitfalls for clients and their attorneys will also be addressed. Reasons for Going Offshore? Although there are many advantages of going offshore to seek asset protection, there are two principal reasons for doing so. First, by utilizing the law of a foreign jurisdiction, the client can utilize the best law available to fulfill the client's goals of effective but legal asset protection. Many offshore jurisdictions have adopted legislation which is specifically designed to offer the maximum amount of protection to the settlor and the assets transferred to a trust by the settlor. This is true even when the settlor is the primary beneficiary of the trust, an option that is generally not available in the United States. Secondly, Americans seek the benefits of an offshore trust to protect assets from the risk associated with having such assets within the jurisdiction of U.S. courts during the pendency of litigation or while a judgment is outstanding. Who Should Go Offshore? An offshore asset protection trust is not for everyone. However, an offshore asset protection trust should be considered by any individual or family who has liquidity in excess of $500,000 to protect. This is particularly true for individuals in high risk professions such as attorneys, doctors, engineers and businessmen, particularly businessmen 8

who are affiliated with publicly held companies. Litigation in these professions is a fact of life that must be anticipated and planned for. Use of Family Limited Partnerships. In many circumstances, it is preferable to transfer most if not all of assets to be protected to a family limited partnership or limited liability company that will be substantially owned by an offshore trust but managed by the settlor in his or her capacity as general partner or manager of the entity. As will be discussed below, such an arrangement allows the settlor to continue to manage protected assets while at the same time effectively transferring virtually all of the ownership interest in those assets to the offshore trust. When NOT To Go Offshore. Just as offshore asset protection planning is an important consideration in advising a client, it is just as important to note what asset protection planning is not. Specifically, asset protection planning is not an excuse to defraud existing creditors. The concepts that will be discussed in this paper are designed to apply to situations where a client wishes to protect his/her assets from the claims of future creditors. Use of the techniques described in this paper in an attempt to or as part of a scheme to defraud existing creditors will, in most cases, fail outright, and in the worst case, result in potential criminal liability to the client and possibly his attorney. II. TRADITIONAL FORMS OF ASSET PROTECTION PLANNING A. Exemption Planning. Texas has long been known as a "debtor haven" throughout the United States. This classification is based upon the liberal property exemptions found in the Texas Property Code. The Code itemizes real and personal property which is exempt from attachment by creditors. Section 522 of the federal Bankruptcy Code also provides a detailed outline of assets exempt from creditors in bankruptcy proceedings. However, the Bankruptcy Code also provides that a debtor in bankruptcy may avail him or herself of either the federal exemptions offered under the federal bankruptcy law or exemptions offered under state law. Because state exemption laws are far more generous than the exemptions offered under federal bankruptcy law, it is customary in Texas that a debtor will rely on the exemptions offered by the Texas Property Code to protect his or her assets from creditors. 1. Real Property. A homestead and one or more lots used for a place of burial of the dead are exempt from seizure for the claims of creditors except for encumbrances properly fixed on homestead property. TEX. PROP. CODE ANN. 41.001. If used for the purposes of an urban home or as a place to exercise a calling or business in the same urban area, the homestead of a family or a single, adult person, not otherwise entitled to a homestead, shall consist of not more than one acre of land which may be in one or more lots, together with any improvements thereon. TEX. PROP. CODE ANN. 41.002(a). If used for the purposes of a rural home, the homestead shall consist of: 9

a) for a family, not more than 200 acres, which may be in one or more parcels, with the improvements thereon; or b) for a single, adult person, not otherwise entitled to a homestead, not more than 100 acres, which may be in one or more parcels, with the improvements thereon. 2. Personal Property. The exemptions for personal property are found in Chapter 42 of the Texas Property Code. Personal property, as described in 42.002 of the Code, is exempt from garnishment, attachment, execution, or other seizure if: a) the property is provided for a family and has an aggregate fair market value of not more than $60,000, exclusive of the amount of any liens, security interest, or other charges encumbering the property; or b) the property is owned by a single adult, who is not a member of a family, and has an aggregate fair market value of not more than $30,000, exclusive of the amount of any liens, security interest, or other charges encumbering the property. Section 42.001(b) provides that the following personal property is exempt from seizure and is not included in the aggregate $60,000 or $30,000 limitations prescribed by subsection 42.001(a): (a) (b) current wages for personal services, except for the enforcement of court ordered child support payments; professionally prescribed health aids of a debtor or a dependent of a debtor. The personal property exemptions provided by Chapter 42 of the Texas Property Code do not prevent seizure by a secured creditor with a contractual landlord's lien or other security in the property to be seized. TEX. PROP. CODE ANN. 42.001(c). Unpaid commissions for personal services not to exceed 25 percent of the aggregate limitations prescribed by subsection 42.001(a) are also exempt from seizure but are included in the aggregate. 3. Retirement Plans State Exemption. The 70th Legislature extended the exemption protections of the Texas Property Code to retirement plans by adding 42.0021 of the Texas Property Code effective September 1, 1987. The provision has been amended several times and was last amended effective August 28, 1995. a. Retirement Plans Protected. Section 42.0021 of the Code provides that, in addition to the exemption prescribed by Section 42.001, a person's right to the assets held in or to receive payments, whether vested or not, under any stock bonus, pension, profit-sharing, or similar plan, including a retirement plan for self-employed individuals, 10

and under any annuity or similar contract purchased with assets distributed from that type of plan, and under any retirement annuity or account described by Section 403(b) of the Internal Revenue Code of 1986, 1 and under any individual retirement account or any individual retirement annuity, including a simplified employee pension plan, is exempt from attachment, execution, and seizure for the satisfaction of debts unless the plan, contract, or account does not qualify under the applicable provisions of the Internal Revenue Code of 1986. 2 A person's right to the assets held in or to receive payments, whether vested or not, under a government or church plan or contract is also exempt unless the plan or contract does not qualify under the definition of a government or church plan under the provisions of the federal Employee Retirement Income Security Act of 1974. 3 To the extent the foregoing state exemptions are held invalid or preempted by federal law in whole or in part or in certain circumstances, the state exemptions remain in effect in all other respects to the maximum extent permitted by law. Contributions to an individual retirement account or annuity that exceed the amounts deductible under the applicable provisions of the Internal Revenue Code of 1986 and any accrued earnings on such contributions are not exempt under Section 42.001 unless otherwise exempt by law. 4. ERISA Protection of Retirement Plans. The Employment Retirement Income Security Act of 1994 (ERISA) is designed to provide federal tax treatment for employee retirement plans and to protect those plans against the claims of creditors of plan participants. The "anti-alienation" provisions are found in 29 U.S.C. 1056(d)(1) and provide that "each pension plan shall provide that benefits provided under the plan may not be assigned or alienated." The purpose of the proscription on alienation and assignment contained in the foregoing section is designed to protect an employee from his own financial improvidence in dealings with third parties, and is intended to assure that the employee and his beneficiaries will reap the ultimate benefits due on retirement. American Telephone & Telegraph Co. v. Mary, C.A. Conn. 1979, 592 F.2d 118. The Bankruptcy Code excludes from the "bankruptcy estate" property of the debtor that is subject to a restriction on transfer enforceable under "applicable non-bankruptcy law." 11 U.S.C. 541(c)(2). In the Supreme Court case of Patterson v. Shumate, the Supreme Court held that the anti-alienation provisions contained in an ERISA-qualified pension plan constituted a restriction on transfer enforceable under "applicable nonbankruptcy law," and thus, the debtor could exclude his interest in such a plan from the property of the bankruptcy estate. B. Domestic Trust. The domestic trust has been successfully utilized by practitioners as a crucial estate planning and asset protection planning tool for decades. Despite restrictions on the ability 1 26 U.S.C.A. 403(b) 2 26 U.S.C.A. 1 et seq. 3 26 U.S.C.A. 1001 et seq. 11

of a settlor to retain an interest in a trust, a properly structured irrevocable trust, where the grantor has "cut the strings" in terms of benefit and control, has been, and still can be successfully used to preserve the assets of the grantor for the benefit of his family. 1. Spendthrift Trust. One of the most common types of trust used in asset preservation is the spendthrift trust. A spendthrift trust is one which provides by its terms that the interest of a beneficiary in the income or principal of the trust may not be voluntarily or involuntarily transferred or otherwise alienated by the beneficiary, except as provided by the trust instrument. The legality of spendthrift trust is recognized in Chapter 112.035 of the Texas Trust Code which provides that a settlor may provide in the terms of the trust that the interest of a beneficiary in the income or in the principal or in both may not be voluntarily or involuntarily transferred before payment or delivery of the interest to the beneficiary by the trustee. TEX. TRUST CODE 112.035. A declaration in a trust instrument that the interest of a beneficiary shall be held subject to a "spendthrift trust" is sufficient to restrain voluntary or involuntary alienation of the interest by a beneficiary to the maximum extent permitted by 112.035 of the Texas Trust Code. 2. Discretionary Trust. A discretionary spendthrift trust provides even greater protection to its beneficiaries than a regular spendthrift trust. In a discretionary trust, the trustee has sole and absolute "discretion" to decide the amount and the timing of income or principal distributions to the beneficiary. Typically, as long as property is held in trust and is subject to the terms of a spendthrift provision, the general rule is that property may not be reached by the creditors of a beneficiary of that trust. However, once the proceeds are distributed to the beneficiaries, they escape the protection of the clause and may be reached by creditors. First Northwestern Trust Co. v. IRS, 622 F.2d 387 (1990). However, the broad discretionary powers of a trustee under an agreement which empowers the trustee full and absolute discretion in making distributions to beneficiaries constitutes a further restraint upon the ability of the beneficiaries of the trust to assign or in any manner alienate the income or the principal of the trust, and represents as well a further immunity from judicial process. First Northwestern Trust Co. v. IRS, infra at 391. Although the courts will recognize that all property of a debtor shall be subject to reach in proper time and manner by his creditors, save only such property as may be legally exempt, the courts will generally not extend this policy to income of discretionary trust funds, which are held in trust for the ordinary and necessary living expenses of the beneficiary, at least until such funds are actually received and held by the beneficiary. Such income does not constitute "property" within the normal meaning of state statutes defining property which is available for execution. First Northwestern Trust Co. v. IRS, infra at 392. 3. Disadvantages of Domestic Trust. Despite their relatively good track record for asset protection purposes, there are two significant problems associated with the use of domestic trusts. 12

a. Rule Against Self-Settled Trust. The reason why so many domestic trusts are established for the benefit of a grantor's family is directly attributable to statutes found in most states prohibiting a settlor from establishing a valid spendthrift trust for his own benefit. The Texas self-settled trust rule is found in 112.035 of the Texas Property Code. It provides that "if the settlor is also a beneficiary of the trust, a provision restraining the voluntary or involuntary transfer of his beneficial interest does not prevent his creditors from satisfying claims from his interest in the trust estate." While the foregoing language prohibits a settlor of a trust from protecting his interest in the trust against his creditors, some consolation can be taken by the settlor in the fact that language such as the foregoing has been regularly interpreted to mean that a creditor can only reach the settlor's interest in the trust. Thus, if the settlor is entitled to receive a distribution of income from the trust, a creditor will be successful in reaching such income distributions. However, if properly structured, a self-settled trust may be able to protect its remaining corpus, theoretically for the benefit of future contingent beneficiaries of the domestic trust. b. Domestic Trusts Are Subject to U.S. Jurisdiction. The fact that a domestic trust is located within the United States makes it a natural and easy target for creditor lawsuits. There are a variety of reasons why a settlor might want to avoid locating a trust within the United States. (i) (ii) Personal jurisdiction. If a domestic trust is already here, it is impossible for it to avoid becoming a target of litigation. Unlike a foreign situs trust with no presence in the United States, it is impossible for a domestic trust to claim that a court in the United States does not have jurisdiction over its assets or the trustees. Thus, even if a lawsuit is frivolous, the trustees of the domestic trust have no choice but to incur the expenditures necessary to defend the trust. Confidentiality. Secrecy should never be a necessary part of a successful asset protection plan. Nevertheless, the high financial profile of most clients involved in asset protection planning makes confidentiality an important goal of many potential settlors. If a domestic trust is sued, literally all of its records and communications, except items privileged by law, are subject to discovery. c. Trust Assets Are Subject To Court Control. A domestic trust, its trustees and its assets, are subject to the whims of state and federal judges. In some cases, U.S. courts have been known to instruct trustees to take actions which are clearly in contravention of the well documented wishes of the settlor. III. THE ALASKA "ONSHORE" TRUST 13

On April 1, 1997, Alaska adopted into law the Alaska Trust Act, House Bill 101. Upon its enactment, the Alaska State Legislature issued a press release entitled "Measure to Strengthen Family Trust Becomes Law." The State of Delaware has adopted similar legislation. Both pieces of legislation are ostensibly designed to provide "onshore" alternatives to offshore trusts. A. The Alaska Trust Act. The Alaska Trust Act changed long-standing Alaskan law by making the following modifications to existing law: 1. Self-Settled Trust Approved. The Alaska Trust Act specifically allows the establishment of a "self-settled trust" wherein the settlor can also be a beneficiary of the trust, can receive benefits from the trust and yet protect those benefits from the claims of future creditors. By eliminating the rule against selfsettled trust, Alaska has theoretically eliminated one of the major obstacles to using a domestic trust for asset protection purposes. 2. Rule Against Perpetuities Abolished. Admittedly, the Rule against Perpetuities is probably an anachronism that has outlived its usefulness. Most of the offshore jurisdictions have eliminated the Rule against Perpetuities as have some states. Thus, with an elimination of the Rule against Perpetuities, an Alaska trust can theoretically continue forever. 3. Secrecy and Confidentiality Protection. Practitioners in Alaska interpret the Alaska Trust Act to ignore that the affairs of an Alaskan trust are not subject to disclosure to third parties. Thus, in litigation against a trust within Alaska, confidential information from the trust will theoretically not be available to third parties. B. Disadvantages and Potential Pitfalls. Notwithstanding the purported merits of the Alaska "onshore" trust, several obvious problems and many potential problems still exist. First and foremost is the fact that trusts and assets located within Alaska are still within the jurisdiction of U.S. federal courts. Federal courts have nationwide jurisdiction which is superior to that of any state court. While federal judges are bound by state law on most matters, that certainly does not apply in the case where federal law has preempted state law including (1) matters of federal income taxation and (2) the power and extent of the bankruptcy court and trustees. Clearly assets transferred into an Alaska trust by a settlor where the settlor has retained a significant interest in the trust would be reachable by both the Internal Revenue Service and a bankruptcy court trustee. In light of the fact that the Alaska Trust Act requires that an Alaska trust maintain a substantial portion of its assets in Alaska and use a trustee licensed by and a resident in Alaska, the bill appears to some commentators to be nothing more than an attempt to attract business to Alaska's banks and trust companies. IV. USE OF FAMILY LIMITED PARTNERSHIPS 14

The family limited partnership has followed closely behind the domestic trust as a favorite of estate planning and asset protection planning practitioners. Although there are a multitude of benefits associated with use of a family limited partnership, the principal benefits can be categorized into several principal groups as follows: A. Valuation Discount. While outside the scope of this paper, a traditional motivating factor in the use of family limited partnerships is the ability to claim significant discounts in the value of the partnership interest owned by a decedent at the time of his death. Notwithstanding the anti-family limited partnership provisions of IRS Code Section 2704, the Internal Revenue Service has conceded the ability of taxpayers to claim a valuation discount for lack of marketability of a minority interest notwithstanding that a controlling interest in the family limited partnership is owned by the same family. B. Income Shifting Benefits. The idea of attempting to allocate income to individual family members in lower tax brackets is not new. The concept first gained popularity at a time when the marginal tax rates in this country were as high as 90 percent. In the leading case of Lucas v. Earl, 281 US 111 (1930), the United States Supreme Court struck down most income shifting structures by holding that the income must be taxed to the individual whose efforts generated the income. Nevertheless, the concept of a family limited partnership was eventually recognized by the Internal Revenue Code in Section 704(e) and Regulation Section 1.704-1(e). IRS Code Section 704(e)(1) provides that a person shall be recognized as a partner for purposes of Subchapter K if he or she owns a capital interest in a partnership in which capital is a material income producing factor, whether or not such interest was derived by purchase or gift from any other person. For purposes of Section 704(e)(1), the determination as to whether capital is a material income producing factor must be made by reference to all of the facts of each case. Capital is a material income producing factor if a substantial portion of the gross income of the business is attributable to the employment of capital in the business conducted by the partnership. In general, capital is not a material income producing factor where the income of the business consists principally of fees, commissions, or other compensation for personal services performed by members or employees of the partnership. Reg. Section 1.704-1(e)(1)(4i). C. Asset Protection Benefit. A third and equally compelling advantage of a family limited partnership has been the limitations placed by most state laws on the rights of creditors to reach a debtor's limited partnership interest. 1. Charging Order Limitation. In most states, such as Texas, a judgment creditor seeking to reach the interest of an owner of a limited partnership interest is limited to use of a "charging order" against the debtor's interest. The Texas charging order statute can be found in Tex.Rev.Civ.Stat.art. 6132a-1, 7.03. The Texas charging order rule provides that: "a. On application to a court of competent jurisdiction by a judgment creditor of a partner or of any other owner of a partnership interest, the court may charge the partnership interest of the partner or other owner 15

with payment of the unsatisfied amount of the judgment, with interest, may then or later appoint a receiver of the debtor partner's share of the partnership's profits and of any other money payable or that becomes payable to the debtor partner with respect to the partnership, and may make all other orders, directions, and inquiries that the circumstances of the case require. To the extent that the partnership interest is charged in this manner, the judgment creditor has only the rights of an assignee of the partnership interest. b. The partnership interest charged may be redeemed at any time before foreclosure or, in case of a sale directed by the court, may be purchased without a dissolution being caused; (1) with separate property of any general partner, by any one or more of the general partners; or (2) with respect to partnership property, by any one or more of the general partners whose interests are not charged, on the consent of all general partners whose interests are not charged and a majority in interest of the limited partners, excluding limited partnership interests held by any general partner whose interest is charged. c. The remedies provided by Subsection (a) of this section are exclusive of others that may exist, including remedies under laws of this state applicable to partnerships without limited partners. d. This section does not deprive any partner of the benefit of any exemption laws applicable to that partner's partnership interest." The fact that a judgment creditor is limited to a charging order has significant benefits. Although the debtor's interest in the limited partnership has effectively been "seized," the creditor is only entitled to receive any distributions which the debtor might have been entitled to. If the Family Limited Partnership makes no distributions to the debtor, the creditor gets nothing. Since the debtor is usually also the general partner, the general partner can decide to retain assets inside the limited partnership. And, since the judgment creditor does not gain any rights or voting power within the limited partnership, his ability to force distributions is very limited. 2. Limited Liability Company Protection. A similar charging order limitation can be found in Tex. Rev. Civ. Stat. art. 1528n, Art. 4.06 which provides that a judgment creditor of a member in a limited liability company can apply to a 16

court of competent jurisdiction for an order charging the membership interest of the member with payment of the unsatisfied amount of the creditor's judgment. However, except as otherwise provided in the regulations of the limited liability company, the judgment creditor has only the rights of an assignee of the membership interest. Thus, the interest of a member charged in this fashion will result in the creditor finding itself in the uncomfortable position of not being able to foreclose on the member's interest or participate in the activities of the limited liability company, but still be required to report the member's pro rata share of income on the creditor's tax return. 3. Revenue Ruling 77-137. An equally effective obstacle to a creditor is Revenue Ruling 77-137 which provides that a creditor who uses a charging order to attach a limited partners income will be treated as a partner in the limited partnership for tax purposes. If the partnership earns income which is then not distributed to the partners, the creditor holding the charging order will recognize phantom income for tax purposes! D. Offshore Limited Partnerships. Many offshore jurisdictions have adopted modern limited partnership legislation which is specifically designed to address the legal and tax needs of United States citizens. Some of the modern offshore limited partnership statutes have been drafted with input from U.S. attorneys active in offshore business and estate planning. Virtually any kind of provision typically drafted into a complex domestic limited partnership agreement can also be drafted into the agreement of an offshore limited partnership with virtually the same legal results being accomplished. From a federal income and estate tax standpoint, assuming all IRS reporting requirements for a foreign limited partnership are met, the tax results are similar, specifically: The offshore limited partnership will file a U.S. partnership return, Form 1065, on which it will report its U.S. source income. The limited partnership interest will be eligible for valuation discounts for gift and estate tax purposes. On the other hand, significant differences in the ownership structure will exist when the offshore limited partnership is formed for asset protection purposes. For example, the general partner will most likely be a foreign limited liability company or International Business Corporation formed in a jurisdiction different from the jurisdiction in which the limited partnership is formed. Additionally, the offshore limited partnership can be formed in a jurisdiction which limits the creditor s remedies to a "charging order" against the limited partnership interest. If the general partner is a foreign limited liability company formed in Nevis, the general partner will enjoy the same charging order protection under the Nevis Limited Liability Company Ordinance of 1995 as the limited partnership. If an offshore trust owns the limited partnership interest, it is possible that a creditor may be forced to consider filing a lawsuit in three 17

different jurisdictions, assuming the creditor has reason to believe it can reach trust assets in the first place. V. FOREIGN SITUS TRUSTS The inherent problems associated with domestic trusts, aggravated by outrageous jury judgments and, in some cases, overreaching judges, have prompted many individuals to seek asset preservation mechanisms beyond the borders of the United States. Although transfers of assets offshore has traditionally been associated with illegal attempts to evade tax or conceal assets, foreign situs trusts have become generally acceptable throughout the world as a legitimate means to deal with the uncertainties of an unpredictable judiciary. There are numerous benefits available to using a foreign situs trust as part of a legitimate asset preservation plan for a client. This is an area of the law that is constantly changing as a result of (i) modernized and more aggressive asset protection trust legislation passed by various offshore jurisdictions and (ii) changing U.S. laws and court decisions apparently in response to the ever increasing use of offshore trusts by U.S. citizens. Nevertheless, a brief summary of the advantages of using a foreign situs trust is as follows. A. Benefits of Foreign Situs Trust 1. Self-Settled Trust Permissible. Most offshore jurisdictions will permit a settlor to establish a self-settled trust wherein the settlor retains beneficial enjoyment or control over the trust assets and/or the administration of the trust, something which is typically not possible in the U.S. Although it is typically a better planning strategy to avoid any unnecessary control on the part of a settlor, the fact that the settlor has retained a beneficial interest in the trust or has a right to exercise certain defined powers in the trust has, in many jurisdictions, been expressly permitted by statute. 2. Chilling Effect of Offshore Trust. Although primarily psychological in nature, a potential creditor and his/her attorney will not welcome the news that a debtor's assets have been sheltered in an offshore trust. An offshore trust constitutes an additional hurdle which the creditor will have to overcome. The mere logistical obstacles presented by the distance of some of these offshore jurisdictions is enough to drive plaintiffs to the settlement table. 3. Non-recognition of Foreign Judgments. Even if a Plaintiff were to obtain a judgment against a Defendant, most offshore jurisdictions will not recognize a foreign judgment. Under the law of most offshore jurisdictions, a creditor must file suit in the jurisdiction in which the trust is located if a creditor intends to enforce a judgment against assets of the trust. Plaintiffs and their attorneys are 18

sometimes surprised to learn that contingency fee arrangements are unique to the United States and, in some offshore jurisdictions, outright illegal. 4. Confidentiality. A legitimate asset protection plan contemplates that a debtor will be prepared to make full and complete disclosure, if compelled to do so, regarding the transfers that were made into an offshore trust. Secrecy should never be a necessary element of a legitimate asset protection plan. Nevertheless, the traditional cloak of secrecy which is found in most offshore jurisdictions is a benefit which is valued by many U.S. clients who wish to keep a low profile for a variety of reasons. Typically, unless the debtor has committed a crime which is also a crime in the jurisdiction in which the trust is located, an offshore jurisdiction will not provide confidential information about the debtor's affairs without the debtor's consent. Since most offshore financial centers are tax havens with no income or estate taxes, no "tax crimes" are legally possible. Thus, almost all offshore jurisdictions will decline to cooperate with criminal tax investigations of the United States or United Kingdom. 5. Unambiguous Fraudulent Conveyance Laws and Statute of Limitations. Few offshore jurisdictions condone a fraudulent conveyance. However, most offshore jurisdictions have attempted to clarify the issue of fraudulent conveyance by drafting clearly defined fraudulent conveyance legislation. This modern legislation has attempted to eliminate many of the ambiguities and unpredictable results which have caused uncertainty for both debtors and creditors alike, both in the United States and in the United Kingdom. Likewise, most jurisdictions have acted to shorten the statute of limitation periods applicable to fraudulent conveyances. (Contrary to popular belief, the Cayman Islands, commonly thought as a debtor haven, has a six year statute of limitations!) 6. Avoidance of Pre-Marital Agreements, Marital Property Laws and Forced Heirship. Regrettably, the sacrament of marriage is not as sacred as it once was. It is not uncommon to have a U.S. client that is working on his third marriage. If the client has begun to accumulate wealth, notwithstanding prior divorces, future marriages can continue to be problematic when the issue of prenuptial agreements is first discussed. The need for a pre-marital agreement can be avoided altogether through the establishment of an offshore trust prior to marriage. It not only avoids the unpleasant task of asking a future spouse to sign a pre-marital agreement, it also prevents the need to make the vast financial disclosure that is required under most state laws to make such agreements enforceable. In fact, the future spouse does not even need to know about the existence of the offshore trust. Upon divorce, the assets in the trust are safely and legally outside the jurisdiction of a divorce court. 19

Likewise, a settlor may be surprised to learn that in most states he will not be able to freely dispose of his property through his Will at the time of his death. Forced heirship laws throughout the United States grant spouses and children of the decedent certain heirship rights in the decedent's estate. These types of problems can be properly addressed through the use of an offshore trust established in a jurisdiction that has adopted legislation to prevent the application of forced heirship laws and forced marital property laws in the debtor's home jurisdiction. B. Selecting a Favorable Jurisdiction. Great care must be used in selecting the situs of an offshore trust. The availability of the characteristics which must be included in a foreign situs trust should be specifically identified in the governing legislation of any jurisdiction being considered for the situs of an offshore trust. Among the factors that should be used in evaluating a particular jurisdiction are: 1. non-recognition of foreign judgments; 2. recognition and protection of self-settled trusts; 3. recognition and protection of trusts wherein the grantor has retained significant control over trust assets or administration; 4. confidentiality; 5. unambiguous fraudulent conveyance laws and favorable statute of limitation periods; 6. recognition of trust provisions which override the forced heirship laws or marital property laws of the debtor's home jurisdiction; 7. favorable tax law (almost all offshore jurisdictions exempt foreign trust from taxation in their jurisdiction); 8. the availability of competent and financially strong trustees; 9. the availability of local professional services, including legal counsel; 10. the proximity of the jurisdiction to the United States; 11. the availability of modern telecommunications, including reliable telephone and communication facilities; 20

12. the compatibility of the offshore jurisdiction to the settlor's language and culture (not all offshore "tax havens" are English speaking); and 13. the existence of a modern and stable government. VI. STRUCTURING AN OFFSHORE ASSET PROTECTION TRUST Many of the considerations applicable to the formation of a domestic trust are also applicable to the formation of a foreign trust. Certain considerations, such as the choice of a trustee, are amplified when using a foreign trustee. Rarely is a U.S. client comfortable with the prospect of having his/her assets and wealth subject to the control of an individual or trust company in a foreign jurisdiction. However, in times of crisis, the competency of the trustee will have a significant effect on whether an offshore trust can successfully withstand a creditor attack from the U.S. A. Significant Offshore Trust Provisions. As with any legal document, a trust agreement for a foreign situs trust should be drafted to reflect the wishes of the settlor. Although such a trust instrument will include provisions which are typically not found in a domestic trust agreement, a practitioner advising a U.S. client on establishing a foreign trust should first identify the settlor's overall wishes and goals. These desires will then be incorporated into the offshore trust agreement just in the same way as they are in a domestic trust agreement. Of course, any such provisions will have to comply with the law of the offshore jurisdiction which has been selected for the trust. In addition to the foregoing, the trust should include the following provisions: 1. Self Settled Trust. Assuming it is permissible under the jurisdiction chosen for the situs of the trust, the trust agreement will usually provide that the settlor has and can retain a beneficial interest in the income or corpus of the trust. Great care should be used in selecting a jurisdiction for such a trust as not all offshore jurisdictions will recognize self-settled trusts. 2. Family Limited Partnership. One of the techniques commonly used to enable a settlor to legally retain control over the assets transferred into a trust is to first transfer those assets into a family limited partnership. The settlor will be named as a general partner of the partnership and retain a 1 percent interest in the partnership. He will also usually be named as the sole limited partner, holding a 99 percent partnership interest. The limited partnership interest is then transferred to the offshore trust. The settlor then continues to effectively exercise control over the assets transferred into the trust without having any actual control or right to control the trust itself. A properly structured offshore trust agreement should nevertheless provide that the trustee may liquidate the family limited partnership and transfer the assets and control of the assets to the trust in the event that an unfavorable creditor situation arises in the settlor's home jurisdiction. 21

3. Ability to Change Situs of Trust. It is not unusual for a U.S. client to respond unfavorably to the idea of establishing a trust in a jurisdiction which he had never heard of prior to consulting with you. If a settlor genuinely is creditor free or solvent, the U.S. client may prefer to establish his trust in a better known jurisdiction such as the Cayman Islands which may not have ideal legislation. In those cases, this problem can be resolved by a provision in the trust agreement which authorizes the trustees to change the situs of the trust upon the happening of certain unfavorable events. Thus, for example, if a trust is established in Bermuda, a "flee clause" will authorize the trustees in Bermuda to change the situs of the trust to a more favorable offshore jurisdiction if it appears to the trustees in Bermuda that the trust will come under attack in Bermuda as a result of unforeseen problems in the debtor's home country. 4. Ability to Change Trustees. The trust agreement should also provide that, upon the happening of certain events, the trustees of the offshore trust may be changed. This can become necessary in a variety of circumstances, not the least of which is a situation where the existing trustee may be found to come under the jurisdiction of a U.S. court. Should that occur, the trust agreement can provide for the automatic removal of the "tainted" trustee and the appointment of a new trustee or trustees. 5. Ability to Move Trust Assets. The trustees of an offshore trust should typically be given broad authority to move assets of the trust for specific enumerated reasons. So long as the trustees have a legitimate reason to continue to protect the assets of the trust, the trustees will owe a fiduciary duty to the trust and its beneficiaries to protect its assets by moving them, if necessary, to a more favorable jurisdiction. 6. Anti-Duress Clause. The mere fact that the law of an offshore jurisdiction allows a settlor to retain beneficial enjoyment or control of trust assets does not prevent a U.S. settlor from coming under the very effective influence of a U.S. judge. If the U.S. settlor resides in the United States, he is subject to the jurisdiction of its courts. If the settlor has retained the ability to control the beneficial enjoyment or administration of an offshore trust, he can be ordered by an American court to exercise those rights and control in a manner which is inconsistent with his goals in establishing the trust to begin with. For example, if a U.S. settlor has retained the right to demand distributions of income or corpus from a foreign trust, a U.S. court can order a settlor under its jurisdiction to exercise those controls in such a way as to repatriate the income or corpus for the benefit of the debtor's creditors. Failure to abide by the court's order will always result in incarceration until the order is complied with. An anti-duress clause in a properly structured trust agreement will permit the trustee of an 22

offshore trust to ignore the settlor's demands if the trustee has reason to believe that the settlor has made the request under duress. 7. Use of a Protector. An alternative to an anti-duress clause is the use of a protector. The concept of a protector is typically unknown within the United States, but is common in offshore jurisdictions. The legislation of most offshore jurisdictions recognize the concept of the protector. A protector is the "guardian angel" of a trust. It is typically an individual who has been granted significant and well defined veto powers over certain proposed actions of the trustee. For example, if a trustee in an offshore jurisdiction should receive instructions from the grantor to repatriate assets of the trust in clear contravention of the settlor's original wishes, the protector has the right to veto such request if the protector, in his sole and absolute judgment, believes that the repatriation of assets would be inconsistent with the settlor's original intent. Powers usually granted a trust protector include the power to: (i) (ii) (iii) (iv) (v) remove a trustee; cause the trust to relocate to another jurisdiction; freeze benefits payable to beneficiaries who have encountered creditor, marital or other problems; add beneficiaries, within parameters outlined by the settlor in his or her "Letter of Wishes"; and authorize the amendment of the trust amendment to update the document for income or estate tax purposes. B. Use of Partnerships with Offshore Trusts. Most offshore trusts utilize the benefits associated with a partnership to hold assets which a settlor transfers to an offshore trust. There are two reasons for this. First, a settlor who is in a position to transfer significant liquidity or assets to an offshore trust is probably qualified to manage those assets himself, particularly if the assets consist of an ongoing business. By transferring the assets to an entity owned by the offshore trust but managed by the settlor as general partner, the settlor is able to continue to manage the assets while achieving a significant degree of asset protection. A second and compelling reason for having assets transferred into a partnership to be managed by the settlor is the reduced managerial costs involved in the management of the protected assets. A trust that owns an interest in a limited partnership is not required to undertake the day to day management of assets as it would if the trust were the direct owner of those assets. As a result, the offshore trustee can justify a substantially reduced trustee fee which might otherwise be as high as 1% the value of the managed assets with a minimum $2,500 management fee. 23